Italian risk – in Italy and beyond
Italy's latest political problems have led to a large rise in their bond yields. Markets seem to have moved too far. Italy is not going to leave the euro. No Italian party wants to leave the euro. Italian voters do not want to leave the euro. Bond markets do not cause monetary unions to break up. It is the cost of bank runs that cause monetary unions to break up.
Political risk continues. New elections are almost certain this year. The outcome is not clear. The different policy views of the League and Five Star have led investors to question the stability of any alliance between the two. Markets should avoid making strong assumptions about policy after any vote.
Political risk may matter beyond Italy. French President Macron has been trying to fix the euro with more integration. Italian politics does not help this. Germany and others may be less keen to support banking and fiscal reforms. Markets had not priced those reforms, however.
Any central bank should set policy using economic data. European economic data remains good. Growth data has been revised up and inflation is rising. However, the ECB has to consider that big market moves may create risks for future economic activity.